Wednesday, August 10, 2011

Sara Lee's Stale Stock

Nobody doesn't like Sara Lee (NYSE: SLE) -- at least that's what its old ad tag line used to say. But should Wednesday's news of a divesture and Thursday's earnings report be reason enough for you to buy the stock?

Ralcorp (NYSE: RAL) is buying Sarah Lee's dough business.  More specifically, Ralcorp will pay $545 million for Sara Lee's North American refrigerated-dough unit to strengthen its private-label brands with pizza and toaster pastries, according to Bloomberg. The price is $100 million higher than one analyst expected and Ralcorp plans to cut about $8 million in costs once it takes control of the business.

Meanwhile, Sara Lee is poised to post Thursday what Zacks Consensus Estimate expects to be $2.2 billion in revenues and EPS of $0.20 a share for its third quarter.

Sara Lee beat expectations in its second quarter reporting adjusted earnings of $0.30 a share -- a nickel ahead of Zacks Consensus Estimate. And Sara Lee's net sales of $2.2 billion were 6.8% higher than the year before driven by 6.1% price increase and 1.3% favorable mix -- but Sara Lee's unit volume fell 3.3%.

But the past is not a predictor of the future -- but it certainly gives some good hints at times. So should you invest in Sara Lee stock? Here are two reasons that might make sense:
  • Reasonable valuation. Sara Lee's price to earnings to growth of 0.89 (where a PEG of 1.0 is considered fairly priced) means it is reasonably valued. It currently has a P/E of 25.9 and is expected to grow 29.1% to $1.06 in 2012.
  • Decent dividend. Sara Lee has a 2.57% dividend yield.
Here are two reasons to pause:
  • Many expectations-missing earnings reports. Sara Lee has beaten analysts’ expectations in three of the last five reporting periods.
  • Shrinking sales and a shakier balance sheet -- but rising profit. Sara Lee has been shrinking slightly with stronger margins. Its $10.8 billion in revenues have declined slightly from $10.9 billion five years ago while its net income of $635 million has risen at a compound annual growth rate of 30% over the last five years -- yielding a modest 6% net margin. Its debt has declined but its cash has fallen faster. Specifically its debt has declined at a 10.4% annual rate from $4.2 billion (2006) to $2.7 billion (2010) while its cash has fallen at an 18.8% annual rate from $2.2 billion (2006) to $955 million (2010).
  • Out-earning its cost of capital -- but getting worse. Sara Lee is earning more than its cost of capital – but it’s doing worse. How so? It produced negative EVA Momentum, which measures the change in “economic value added” (essentially, after-tax operating profit after deducting capital costs) divided by sales. In the first nine months of 2011, Sara Lee ’s EVA momentum was -2%, based on first nine months' 2010 annualized revenue of $8.6 billion, and EVA that fell from $252 million annualizing the first nine months of 2010 to $113 million annualizing the first nine months of 2011, using an 8% weighted average cost of capital.
Sara Lee makes tasty products but it lacks any catalyst for a purchase of its shares. There is a chance that it could exceed expectations when it reports Thursday -- but if it misses, the stock could plunge. If history is any guide, its odds of missing are pretty high.

I would wait to buy this stock until management can demonstrate that it can boost revenues -- not just cut costs and sell businesses.


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